December 22, 2004

Do brands Matter ?

As an investor one of the key elements to analyse in a company is the durability of its competitive advantage. A durable competitive advantage enables a company to earn excess returns over its cost of capital. There are several examples in the indian industry like levers, Proctor and gamble , asian paints etc with strong and durable competitive advantages

One of the key elements of the sustainable competitive advantage is strong , well know brands. The examples above clearly reflect that. Companies with strong brand are able to withstand competition better and provide investors with superior returns. But how durable are brands these days ? Can we as investors be confident that consumers would be faithful to their brands and would pay that extra for their special brand.

Brands like surf, colgate, cadbury etc are well know brands for last 25 years. However these brands are struggling in terms of growth and retaining the existing customers and being relevant to the new ones. A lot of articles and studies do point to rampant brand switching among consumers . Have the consumers become unfaithful or these brands lost their relevance. I would assume partly both. Who gets excited with a new brand of toothpaste or soap. But mobiles / cars are a different matter. These product categories get a lot of consumer interest (brand loyalty is a different issue).

In the international markets, brand loyalty is at an all time low. Nokia is one of the most admired and liked brands. In 2003 i think they missed out on the trend of clam shell mobile phones and paid heavily for it ( they lost market share). I dont have tell what happened to the stock price. The new reality which marketers have to live with is this : What have i done for my consumer today ? Is my brand still relevant to my consumer

What does all this mean for an investor ? Very simply - Higher ad expenses, shorter relevance of existing brands, lower success rates of new brands. All this translates into one conclusion - The excess returns enjoyed by companies due to their dominant brands would reduce. They would still be good businesses (much better than commodity business). however investor will pay less for such businesses ( Lower PE's).

The above has already happened for a lot of consumer companies. Several do not enjoy their historical PE's. analysts keep fretting about monsoon and kharif crops and what not ? They have not been able to explain why Mobiles companies, car companies do well whereas FMCG companies continue to have poor growth rates. It would be critical for an investor to answer the above question before investing in a company. Try challenging the convential wisdom ...the conclusions could be interesting


Vidyanshu said...

Hi Rohit,

You know this is interesting! I read somewhere that Warren Buffett decided to invest in some companies because he thought that the brand valuation was not factored into the intrinsic price and therefore they were value buys.

I was wondering along these lines, I have yet to see Indian companies adding a placeholder in their sum of parts analysis..Do you think using brand valuation to see whether a stock is a value buy is a good idea?

Rohit Chauhan said...

Hi vidyanshu

i personally would not want to factor brand value in the valuation. If the brand is adding value (and not all do), then it must be reflected in the profit and cash flow of the company. so considering it again may result in counting it twice.

If the brand is in the early investment phase then i would prefer to wait and see if it is successful or not